How can I tell If my Company is Insolvent?

One particularly crucial question that any business needs to ask themselves during challenging periods is a simple but direct one - “Is my company making money?”

At the end of the day, any company that isn’t making money is failing and ultimately this could lead to insolvency.


Determining whether your company is making money can be as easy as checking your end-year management accounts and reviewing your bank accounts. The question of solvency can be a little more complicated to answer.


From a professional standpoint, Insolvency happens when a business can no longer meet the financial obligations that have been set in place between it, and its lenders, or lender.


Technical Insolvency can lead to insolvency proceedings, in which creditors take legal action against the insolvent business in an effort to use some of the company’s remaining assets to pay off the mounting debts. 


Insolvency can happen for any number of reasons – from poor cash management, to differences in forecasted cash flow, or simply sheer bad luck.


But how can you tell for sure if your business is insolvent, or whether it’s heading in that direction?


Many companies complacently believe that insolvency is a straight-forward condition that’s easy to diagnose. However, the truth is that many businesses which appear to be secure, are actually insolvent.


While every financial situation is different, in general, there are three primary methods that can be used to identify business insolvency. 


These relate to: 

  • The Balance Sheet
  • Available Cash Flow
  • Legal Action


The Balance Sheet


Does the business owe more than it owns?


The first key insolvency test starts with your balance sheet. If the assets generated by the company are greater than the liabilities contained within it, then that business is solvent.


On the other hand, if the liabilities of a business outweigh the assets, it will be deemed insolvent. 


Take a look at the current assets available to the business at this time, and try to add them up to get a basic estimation of the overall business worth of the company.


After that, make a list of all the debts and payments that you’re expected to make to creditors in order to keep your business running.


If the two lists don’t balance, and you’re in a position where you’re paying out more money than is coming in, then this could be a sign of impending insolvency. 


After all, no business can be successful when the costs of running its operations are higher than the profits obtained from those same operations!


Available Cash Flow


Can the business pay debts when they come due? 


Your cash flow will be unique to your business, so it’s important to remember that even if you look at example cash flows online, they won’t be able to offer you a totally accurate insight into what your balances should ideally look like. 


Always examine the numbers in your cash flow carefully and think about the terms of your suppliers.


If you have supplier terms with a limit of thirty days for payment, does your cash flow suggest that you will be able to make the payment in that time, or do you often have to ask for extensions? 


At the same time, think about your employees, and whether you’re able to pay their tax deductions and National Insurance to HMRC by the 19th of each month. If you’re struggling to make payroll every month then this is a clear sign that you could be in trouble. 


If your VAT and PAYE are quickly adding up, and you’re unable to pay debts when they’re owed, then your business is probably insolvent.


The cash flow test is generally seen as the most stringent insolvency tests as it’s where a number of struggling small companies have had difficulties over recent years.


Legal Action


Are creditors taking the business to court? 


The legal action test asks whether your company creditor has been able to bring a successful legal action against your company as a result of an unpaid debt.


This would mean that either one or more of your company’s creditors have applied for a Statutory Demand against your company or has been granted a County Court Judgement (CCJ) against you. 


If a creditor has obtained judgement against the business in a court of law, and the court states that the business should pay them any money which remains unpaid, the court may need to examine your finances and officially designate your business as insolvent.


If this happens, then the creditor may attempt to recover a portion of the money through bailiffs or they might even petition the court to begin bankruptcy proceedings that would force the company to close.


Any creditor owed more than £750 by a business can petition the court to order that company into liquidation if the debt cannot be settled within a period of 21 days.


It’s that serious. 


Other Indicators of Impending Insolvency


While the three tests covered above are the main indicators of insolvency, other signs may emerge that might require you to rethink the finances and solvency of your business.


For example, if you’ve been avoiding paying taxes such as PAYE or VAT on time so that you can pay other creditors that are vital to your business instead then this could be a sign that you are headed for insolvency.


It’s also unwise to make an enemy of HMRC as they will be the most determined creditor you can imagine. 


Some other potential warning signs can include:-

  • Constant losses – every company makes losses during the life cycle of its trading experience, and these aren’t necessarily a sign that the company is insolvent. However, when the losses in question can’t be covered by the working capital of the business, then this could indicate that the business is not far from a critical situation
  • Liquidity – is the company’s liquidity ratio under 1? In other words, do the available liquid assets cover the business’s debts? While it might simply be a sign of bad times, it can also indicate encroaching insolvency
  • Banking problems – If your bank is refusing to issue funds, decreasing your overdraft or returning business cheques then this is a real red flag. 
  • Raising capital? – If you need to seek fresh and additional investment just to be able to pay bills when they fall due then this is a big signal that insolvency might not be far away
  • COD Arrangements – If your suppliers place you on a Cash on Delivery or “COD” arrangement, or demands payments before resuming supply, this could be a clear indication that the supplier has no faith in your company’s ability to pay on time and ultimate solvency.


What Should You Do If You think your company is insolvent?


The best thing you can do is to seek immediate professional advice from an Insolvency specialist or business restructuring professionals.


They’ll be able to give you further advice on what you need to do next and what options are open to you depending on your own unique situation. 


If you think that your business is insolvent than crossing your fingers and hoping for the best is not an effective strategy – especially if you’re a director. 


Directors have the additional responsibilities of managing the best interests of creditors as well as doing their best for their business. 


There are legal considerations and consequences to insolvency that fall on directors including the possibility of personal liability of incurred debts and possible malfeasance.


Yes, these are serious consequences but insolvency is a serious problem that has to  be given your full attention when you discover it.